What to do to reduce the chance of an IRS audit

It's Your Money

This is the final part in a two- part series about being audited by the IRS.

Last week, I presented information regarding your chances of being audited. For certain taxpayers, the odds are not getting better for you. So what can one do to reduce their chances of being audited?

I have an acquaintance who has taken the extreme step of taking some of his assets off shore and having the income from the assets be treated as non U.S. income. I don't recommend this as a viable option. The IRS is attacking this method of tax avoidance aggressively.

For most of us, we don't have enough assets to seriously consider such an extreme measure in the first place. So let's see what steps we can take to reduce the chances of being audited.

First, you should audit your own return before you send it in. If the IRS finds mistakes through its increasingly sophisticated computer-checking equipment, you're more likely to be audited. They figure that if they find obvious errors, some not-so-obvious ones lurk beneath the surface.

Have you included all your income? Think about the different accounts you had during the tax year. Do you have interest and dividend statements for all of your accounts? Finding these statements is easier if you've been keeping your financial records in one place. Check your W-2s and 1099s against your tax form to make sure that you wrote the numbers down correctly.

Check the math. With tax software programs, we all assume that the math must be correct. Programs have been known to make computational errors so don't ignore this part.

Which leads me to a big question: If you have your tax return prepared by tax professionals, who is responsible for the accuracy of the return, you or the tax professional? Answer: You are. So just because you had your return prepared professionally, don't forget that you are still ultimately responsible for what goes on the return. You still need to review it carefully. Tax professionals have been known to make mistakes too (heaven forbid!).

Second, declare all of your income. When you prepare your return, you may be tempted to shave off a little of that consulting income you received. That's not a good idea. The IRS has many ways of finding unreported income thanks to new cross checking computer programs. When you knowingly hide income, you face substantial penalties and, depending on the amount, criminal prosecution.

Here are some other suggestions that may help:

* Don't itemize - People who itemize their deductions on Schedule A are far more likely to be audited because they have more opportunity and temptation to cheat. However, if the itemized deductions give a greater deduction as opposed to a standard deduction, then by all means, itemize.

* Earn less money - There are costs associated with affluence. One of those costs - besides higher taxes - is a dramatic increase in the probability of being audited.

* Don't cheat - The government is methodically figuring out the different ways that people cheat. The IRS is coming up with ways to catch cheaters so beware.

* Stay away from back-street refund mills - There are some tax preparation firms that do fabricate deductions. Run away from tax preparers who tell you, after winking, that they have creative ways to reduce your tax bill, or those who base their fees on how many tax dollars they can save you. Also beware of any taxpreparers who promises you a refund without first thoroughly reviewing your situation.

* Be careful with hobby losses - Some people who have full-time jobs also have sideline businesses or hobbies with which they try to make a few bucks. But be careful if you report the avocation as showing a loss year after year on your tax forms. Filers of Schedule C, Profit and Loss from Business, are at greatest risk for audits.

* Don't be a nonfiler - The IRS has a special project with a mission to go after the estimated 5 million or more nonfilers. Again, when you get caught - which is just a matter of time - in addition to owing back taxes, interest and big penalties, you may also face criminal prosecution and end up serving time in the slammer. And remember, better late than never!

* Carry a rabbit's foot - Try as you may to be an obedient taxpayer, you can be audited simply because of bad luck. Every year, the IRS audits some taxpayers at random. If you do get an audit notice, don't assume that you did anything wrong. It happens to the most well-intentioned taxpayers.

D. Frank Norton CPA, MBA, CFP, is a money manager and financial planner in Santa Clarita. His column represents his own views, and not necessarily those of The Signal. "It's Your Money" appears Thursdays and rotates between a handful of the Santa Clarita Valley's financial professionals.